Asian Countries Move Toward Risk-Based Capital Solvency Framework

The global financial crisis has validated the critical role risk management plays in value creation for the insurance industry, pointing to the need for a risk-based capital solvency framework across Asia, according to market practitioners.

In Asia, the European Union's Solvency II framework is viewed as best practice, with the support of both insurers and regulators, said David Lightfoot, managing director of Guy Carpenter Instrat, the reinsurance broker's risk modeling unit.

The fundamental concept and direction of most Asia-Pacific countries is consistent with those with the International Association of Insurance Supervisors. "Every country is moving towards that direction but at a different speed," said Lightfoot.

Timing will be different for different countries, given the diversity across Asia. For instance, China has been looking into the risk-based capital framework for solvency requirements. But it is still difficult for China to switch to the Solvency II type of framework because industry data is still developing, an area that needs more effort.

In Asia, Lightfoot said he is "not much aware" of any formal cooperative agreement or regulatory integration other than general adherence to the principles of IAIS in Solvency II.

Managing value is especially important in times of financial crisis because of increasing capital costs, tightening capital supply and difficult profitable growth in the markets, said Joan Lamm-Tennant, chief global economist and risk strategist at reinsurance broker Guy Carpenter.

Speaking at a regional risk management conference in Asia, Lamm-Tennant said profitable growth has been impeded by capital shock during the crisis, and this has partly removed the incentive for new investment. As companies are unable to fund new investment, the main capital source for investment becomes internal, which is cheaper than external capital.

In managing profitable growth, Lamm-Tennant said insurers' capital strategies should include contingent equity, lines of credit, reinsurance and derivatives. Long-term profitable growth can be promoted by protecting earnings from risks, hence ensuring a reliable source of capital for funding new and ongoing investments.

"Instead of thinking about risk management as risk transfer, the objective is to ensure availability of capital to fund future investment," said Lamm-Tennant. The crisis heightened the value in protecting internal capital.

In creating economic value, Lamm-Tennant said it is all about generating returns on capital and managing cost of capital. Risk management becomes a crucial part of value creation for insurers in view of increasing volatility in earnings and capital in the markets.

Value creation is about managing risk and capital to achieve solvency, profitable growth, transparency and improving corporate governance. Lightfoot said these areas are essential strategic pillars for risk management. As insurers are exposed to multiple markets and business lines, a sophisticated risk management model is necessary to cope with volatility.

In recent regional meetings with insurance professionals in Asia, Lightfoot noted there is "a fair amount of enthusiasm" in getting value back and doing a better job of risk management. Insurers' concerns focus on the area, scope and process of risk management. They are "actively" engaged in improving risk management and competence.

Capital supply has started to replenish this year, as shown by a pick-up in catastrophe bond markets, according to Lightfoot. Although global capital markets have showed signs of recovery, there is still plenty of worry after last year's capital shock.

Among lessons learned in the past year, the financial crisis was primarily driven by assets rather than liabilities, and systemic risk is critically relevant. Correlation between lines of business and assets are much stronger in the wake of the crisis. In managing solvency risk, Lamm-Tennant cited the importance of asset and counter-party risk and enterprise risk management.